Securities Lawyer Blog

In another settlement between the Financial Industry Regulatory Authority (FINRA) and Merrill Lynch, the firm has agreed to pay a fine of $1 million for its alleged failure to arbitrate disputes with employees with regard to retention bonuses. The allegations involved the way the retention bonus program was handled after the firm's merger with Bank of America in January of 2009.

The firm established a bonus program after the merger that was intended to retain registered representatives who were high-producers. Participants in the bonus program were required to sign a promissory note related to these bonuses, that forced them to resolve disputes with the firm in the state courts, rather than in arbitration proceedings. FINRA found that the way this program was structured, employees could secure unpaid bonuses only by litigating in the courts. This effectively avoided the applicable arbitration rules that require disputes between firms and associated persons be arbitrated when they arise out of the business activities of the firm or associated person.

Specifically, in early 2009, the firm paid $2.8 billion to 5,000 registered representatives in retention bonuses. The bonuses were in the form of promissory notes which as previously noted, required the registered representatives to litigate any issues related to these bonuses in the state courts. This was said by FINRA to place a limitation on "the ability of defendants to assert counterclaims in such actions."

In addition to the issues relating to the forum in which disputes involving the promissory notes could be resolved, FINRA also alleged that the firm used Merrill Lynch International Finance, Inc. (MLIFI), a non-registered affiliate, rather than Merrill Lynch itself, as the source of the bonus payments. This was intended to enable MLIFI to file expedited hearings in New York state courts with regard to the promissory notes and was allegedly structured to avoid the requirement that the firm arbitrate disputes.

When many registered representatives left Merrill Lynch in late 2009, but did not pay back their loans under these agreements, the firm filed for expedited hearings in New York state court for recovery under these notes. This was alleged by FINRA to have directly violated FINRA rules requiring arbitration, as well as making it impossible for the registered representatives to assert potential counterclaims with regard to the bonuses.

The New York firm of Gusrae Kaplan Nusbaum PLLC advises broker-dealers and firms in all aspects of regulatory compliance. Our skilled and experienced lawyers represent industry members before all regulatory entities. Contact our law firm to consult with one of our attorneys.

The Financial Industry Regulatory Authority (FINRA) is going on the offensive to protect the investing public against email hacking attacks in which fraudulent transfers are being made. Issuing both a Regulatory Notice 12-05 and an Investor Alert that is aptly titled: Email Hack Attack? Be Sure to Notify Brokerage Firms and Other Financial Institutions, the agency has blanketed the subject due to what it says are increased reports of email and account invasion by hackers that are leading to investors' funds being stolen.

At first glance, the scenario is similar to other email scams, but these attacks differ in a significant way. In past instances, customers are sent emails asking for private information that is then used to fraudulently obtain information that allows outsiders to gain access to accounts.

As noted in the Regulatory Notice executive summary, the scheme has several steps that make it appear that the transfer requests are legitimate. But in fact the perpetrators have gained access to an investor's email and contact lists and that information is then used to instruct firms to make transfers into accounts controlled by third parties, not the investor. In some instances, these fraudulent "instructions" might include what are also fraudulent letters of authorization that attempt to pressure firms into releasing funds prior to a follow-up phone authorization.

The FINRA warning is intended to inform the public to avoid these circumstances by safeguarding assets. The Regulatory Notice is also intended to halt this trend by helping firms understand that allowing or accepting email instructions is fraught with risk. The hope is that firms will reassess their policies with regard to instructions, which should help protect against this fraudulent practice on the part of hackers.

Once an individual is aware of or suspects that email has been compromised, FINRA is asking that investors immediately inform their brokerage firms or financial institutions of this problem.

Referring generally to NASD Rule 3012 and NYSE Rule 401, RN12-05 reminds firms that they must establish, maintain and enforce written supervisory control policies and procedures that are reasonably designed to review and monitor the transmittal of funds or securities from customer accounts to third-party accounts. These requirements and their scope have been delineated in Regulatory Notice 09-64, which "highlighted a number of questions firms should consider in assessing the adequacy of their policies and procedures for verifying the validity of requests to withdraw or transfer customer funds."

This increase of fraudulent email activity serves as a reminder that firms should be vigilant in assessing and establishing policies and practices as to electronic communications with investors. Assessing the risks involved with the way in which investors are permitted to communicate instructions for the withdrawal or transfer of funds through electronic means, including verification and follow-up, are recommended.

The lawyers of Wall Street's Gusrae Kaplan Nusbaum PLLC are experienced advisors to firms and broker-dealers in all areas of compliance. Contact our law firm for more information on our wide range of services, including litigation and enforcement representation. We are a firm comprised of experienced former senior level regulators and securities and compliance litigators, providing advisory services to our clients in regulatory compliance.

Northern Trust Securities, Inc. will pay a fine of $600,000 to FINRA for alleged lack of proper supervision in the areas of collateralized mortgage obligations (CMO's) and high-volume securities trades. FINRA claims that the firm did not monitor nearly 45% of their business over a year and one half time frame.

The allegations regarding lack of supervision and monitoring of customer accounts centered on a three-year period between 2006 and 2009. The claim is that due to the firm's alleged issues with monitoring, some accounts ended up with CMO's in concentrations that were not suitable for the account holders.

The underlying reason was stated to be because the firm "used an exception reporting system that failed to capture or analyze substantial portions of the firm's business, including all CMO transactions, certain trades of 10,000 equity shares or more, and certain trades of 250 or more of fixed-income bonds."

Without the appropriate systems in place to monitor equity trades at certain levels (10,000 shares, for example or large numbers of bonds in fixed income) the firm is alleged to have allowed trades to occur that were not monitored for suitability, concentration and other issues such as the rate of mark-ups and commissions.

Overall, FINRA pointed to a lack of monitoring that, according FINRA's Executive Vice President and Chief of Enforcement Brad Bennett, "allowed more than 40 percent of its transactions to proceed without review, which in turn left vulnerable investors exposed to the risk of losing all or a substantial portion of their principal through potential over-concentration in CMOs." The firm has consented to the settlement without an admission or denial of the charges.

Appropriate monitoring and supervision have been the subject of prior posts by the lawyers at the Securities Lawyer Blog. Compliance in this area continues to be important for broker-dealers.

Our New York securities litigation firm advises broker-dealers to ensure that they have proper systems in place to comply with industry rules and practices. We also represent industry members before all regulatory agencies. For more information on our law practice and representation, or to speak with one of our experienced securities litigators, please contact Wall Street's Gusrae Kaplan Nusbaum PLLC.

FINRA has just issued an investor alert on stock-based loan programs -- using their enforcement actions in this area as support for their caution to investors that these can be risky. The new alert, entitled "Stock-Based Loan Programs: What Investors Need to Know" is intended to ensure that investors are aware of both the risks and the rewards of these loan programs. But there is an enforcement issue brewing beneath the surface of this warning and the industry also needs to take note.

Warning that these loans can be "tempting" for investors who would like to hold investments while taking cash or value for other purposes, FINRA wants investors to consider the risks particularly when these loans are being offered by "unregistered, unregulated third-party lenders." They also caution investors that these programs can carry with them unintended tax consequences.

Before arranging for a loan of this type, FINRA wants investors to consider such issues as the costs and risks of the loan, possible taxable events, the source of the loan and whether the lender is registered either with banking regulators or with FINRA itself.

Those in the industry are aware that these programs provide investors an opportunity to pledge their fully paid stock as collateral -- but these loans when provided by unregistered third-party lenders can be very problematic for the investor. Noting that these programs are often offered by financial planners and insurance agents, FINRA states its concern that borrowing funds against an investment portfolio may not be wise for many investors lured by the possibility of holding their portfolios while using the funds from the loan program.

But the programs are fraught with risks. Once the stocks are pledged as collateral for the cash loan provided, the investor not only will owe the interest which can be at a high rate for the duration of the loan. Dividends are still paid and credited against the loan. At the end of the loan period, the investor can extend the loan or take back the stock.

FINRA's concern is that the investor might also have a big bill to pay at the end of the loan and not be aware of this, since it is possible that the Internal Revenue Service will view the transaction as a stock transfer which triggers a taxable event. This can include possible capital gains which might be based either on the loan proceeds receipt or the stock sale, if that occurs at the end of the loan period.

Recourse for investors concerned about a problem with a stock-based loan is available on FINRA's online Investor Complaint Center.

The New York securities regulation and enforcement attorneys at Gusrae Kaplan Nusbaum PLLC represent broker-dealers in regulatory and enforcement matters before FINRA and other regulatory agencies. Our lawyers advise and defend industry members in matters involving a broad spectrum of issues. Please contact our law firm to consult with one of our attorneys.

As Wall Street securities lawyers, we know what the law requires and what regulators expect from broker-dealers and we routinely advise industry representatives on compliance so that they can avoid potential problems traversing the vast regulatory schemes that govern the securities industry.

The consequences to a broker-dealer for failing to comply can be harsh. Losing the ability to work in the industry is one of the harshest blows one can experience. We report on cases in which industry members have been fined or barred so that others might ensure that they are in compliance and are reminded of some of the activities that can lead to major consequences.

In a recent case out of Chicago, a now-former registered representative has been barred by the Financial Industry Regulatory Authority (FINRA) for two major alleged breaches of industry rules and regulations: insider trading and failing to truthfully respond to questions by investigators in FINRA's Office of Fraud Detection and Market Intelligence (OFDMI).

The former representative has also been fined for the illegal profits gained during illegal transactions. He had served as a divisional vice president of Pacific Select Distributors, Inc. for a five-year period.

During this time, he obtained significant insider information about Boots & Coots, Inc. (WEL) that the company was about to be acquired. He then purchased 73,000 shares of the company prior to the acquisition by Halliburton, which resulted in nearly $70,000 in illegal gains. He then sold his shares and profited as a result. While working this case, FINRA found that this representative had "purchased shares of WEL while in possession of material, non-public information about the company's pending acquisition."

FINRA also found that he allegedly failed to comply with FINRA Rule 8210, requiring an individual who is under investigation to testify truthfully while under oath. Rather, it is alleged that the member gave untruthful statements to OFDMI investigators responding with false information that the WEL shares were purchased based on research that he had performed. He did not disclose that an insider provided him with information and denied knowing anyone "currently or formerly employed at WEL." But this allegedly turned out to be false.

This case underscores the fact that FINRA has made its intentions clear to members -- they will deal "aggressively with any individuals who lie to or mislead our investigators."

The New York securities regulation and enforcement attorneys at Gusrae Kaplan Nusbaum PLLC represent broker-dealers in regulatory and enforcement matters before FINRA and other regulatory agencies. Our lawyers advise and defend industry members in matters involving a broad spectrum of issues before regulatory bodies, including sales practice violations; Forms U4 and U5 reporting violations; Insider trading; Trading issues and many more areas of regulation and enforcement. Please contact our law firm to consult with one of our attorneys.

When firm's sell mutual fund shares to customers, delivery of the fund prospectus matters and for some that is a tough lesson to learn. Wells Fargo Advisors has just agreed to settle its alleged failure to timely delivery prospectuses to customers in the purchase of mutual funds in 2009.

The Financial Industry Regulatory Authority (FINRA) issued a press release yesterday to announce that the firm has agreed to pay $1 million for prospectus delivery delays. In addition, the firm is settling alleged delays in informing and reporting to customers fully about certain issues involving arbitrations and complaints with mutual fund representatives.

The allegations center around prospectuses for mutual funds that were allegedly delayed from as little as one day and as long as 153 days. The federal securities laws require that these be delivered within three business days after the transaction has occurred.

But the problem for Wells Fargo apparently did not end with delivery issues. According to the allegations in this matter, the outside provider that mails prospectuses for the firm informed Wells Fargo that some customers did not receive them in a timely manner. FINRA alleged that even after learning of this, Wells Fargo did not rectify the situation.

The notice to Wells Fargo was provided in the form of quarterly reports that apparently revealed that a percentage of the mutual fund purchasers had not received timely mailings. Further, the firm received notice in daily reports that delivery had not been accomplished for some customers. The firm did not correct the situation even after receiving more specific notice of this problem.

A tough lesson learned, but the lessons did not end there. The firm also settled alleged violations of FINRA rules in addition to these allegations. FINRA claimed that Wells Fargo "did not promptly report required information to FINRA regarding its current or former representatives."

Specifically, the requirement under FINRA rules that a securities firm ensure that Forms U4 and U5 are current regarding a representative's termination, formal investigation, customer complaints or arbitrations. As part of this matter, FINRA determined that the firm did not update about 8 percent of Forms U4 and over 7 percent of Forms U5 in a timely manner.

The New York securities regulation and enforcement attorneys at Gusrae Kaplan Nusbaum PLLC represent broker-dealers in regulatory and enforcement matters. Our lawyers advise clients and defend industry members in matters involving a broad spectrum of issues before FINRA and other regulatory bodies, including sales practice violations; Forms U4 and U5 reporting violations; Insider trading; Trading issues and many more areas of regulation and enforcement. Contact our law firm to consult with one of our attorneys.